Narrative R&D disclosure and insider trading profitability: Evidence from China

This paper investigates how narrative R&D disclosures affect firms’ information asymmetry from the perspective of insider trading profitability. Inconsistent with the traditional information economics theory that information disclosure can alleviate information asymmetry, we find robust evidence that insiders in firms with more narrative R&D disclosures gain significantly greater returns from their stock selling, but this positive relation is attenuated when the readability of R&D-related texts is higher. We examine two potential channels through which more narrative R&D disclosures increase information asymmetry, thus creating opportunities for insiders to trade profitably. One is managers’ obfuscation disclosure of narrative R&D information due to proprietary costs, and the other is the high information processing costs associated with the technical nature of R&D information. We also find that good corporate governance mechanisms can weaken the positive association between narrative R&D disclosure and insider trading profitability. In further analysis, we provide evidence that more narrative R&D disclosures indeed exert high information processing costs for investors and provide opportunities for insiders to trade more before bad news arrives. Overall, our research sheds light on the dark side of narrative R&D disclosure on firms’ information environment from the perspective of insider trading.